The Most Important Chart of the Century? Yes, I think it is. Diminishing Marginal Productivity of Debt

When I saw the title of this article I thought "oh yeah, bound to be an exaggeration".
But when I saw an updated version of a familiar chart, I thought "no, that could well be THE most important chart to understand".

IMO this is a subject that deserves a little time to understand. The inescapable conclusion is profound.

The latest U.S. Treasury Z1 Flow of Funds report was released on March 11, 2010, bringing the data current through the end of 2009. What follows is the most important chart of your lifetime. It relegates almost all modern economists and economic theory to the dustbin of history. Any economic theory, formula, or relationship that does not consider this non-linear relationship of DEBT and phase transition is destined to fail.

It explains the "jobless" recoveries of the past and how each recent economic cycle produces higher money figures, yet lower employment. It explains why we are seeing debt driven events that circle the globe. It explains the psychological uneasiness that underpins this point in history, the elephant in the room that nobody sees or can describe.
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Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!

This is mathematical PROOF that debt saturation has occurred. Continuing to add debt into a saturated system, where all money is debt, leads only to future defaults and to higher unemployment.

For those who think it's not worth the time, here is a very quick summary of the idea, which I hope encourages you to go read the full description.

Let's take an example of a company. It starts in say 1966 and borrows some currency in order to invest and hopefully increase profits. You can calculate the increased profit versus the increase in debt. Call the result the "Marginal Productivity of Debt".

As the years go by the company borrows more in the hope of increasing profits.

The chart above shows what has happened to that company over the years.
It shows what effect each extra bit of borrowing has had on profits.

It shows that each extra debt has resulted in less extra profit.

Now one could argue that interest rates should be included in the calculation, since interest rates affect the cost of debt.
But this chart ignore the constant fluctuation of interest rates and just looks at the most simple relationship over the very long-term.
Did the extra debt result in better profits?

The whole point is that if the ratio of extra profit to extra debt reaches zero, any extra borrowing now has no effect on profits. The company has become incapable of growing.

Even worse, if the line crosses zero, extra debt actually results in a reduction of profits. Extra debt results in the company shrinking instead of growing.

This idea has been applied to the US economy.
And zero has been crossed even sooner than my red wiggle suggested.

Extra debt taken out by the US now will result in the economy shrinking. And the faster debt is taken out, the faster the economy will shrink.

If that is not a very important chart....I don't know what is

The US economy is the biggest in the world, and the US Dollar is the main reserve currency of the world.
That makes this important for everyone, and means they should prepare accordingly.

Here are two very good options for buying gold & silver and having them stored for you in secure insured vaults:

The US Economy is bifurcated, with price inflation advancing on the cost side while price deflation harms on the asset side, to produce a nasty storm that is unlikely to abate.

As I said, falling prices in what you own and rising prices in what you need. That's why I disagree with Mush that house prices should be included in the "inflation" numbers. Combining data means losing information.

And Willie isn't fooled by the official fiddled CPI numbers

Quote:

The maestros believe that new money or new debt (hard to tell the difference)

Actually it's easy to tell the difference. Money needs to be something with intrinsic value. Gold & silver can act as money, but the current fiat currencies are just currencies, a means of exchange.

Read an NZ 50 Dollar note. It says "This note is legal tender for fifty Dollars" !!!
It has no real value. It's not even nice paper, it's yucky plastic. There's no pretence that it has any value.